Bond Preview:

Strong economic data expected to keep prices down

By

DanielF. Floyd

WASHINGTON (CBS.MW) -- Activity in the fixed-income market next week is likely to be determined largely by two reports: the Institute for Supply Management survey on Monday, and the employment report released by the Labor Department on Friday.

Many analysts believe that Treasury bond prices are set to remain in the negative column, as strong data suggest that the economy might be recovering. Following a stronger-than-expected Chicago PMI report Friday, the Dow Jones Industrial Average rallied, a move that tailed off late Friday.

While economists are undecided about the extent to which promising industrial production data could sustain gains in the stock market, they are almost unanimous in their belief that the employment report is the most important gauge of the U.S. economy set for release in the coming week.

Mark Vitner, senior economist at Wachovia Securities, suggested that, in addition to the two big reports, market conditions are being affected by political concerns, especially tensions between India and Pakistan.

The ISM survey should reveal a strong increase in manufacturing on a nationwide basis, although it probably will come in short of expectations, which have been inflated by the results of the Chicago PMI report released on Friday. "People do not realize that the Chicago area has a concentration of durables, which are making a strong comeback," Vitner explained. The prices paid series is up in Chicago, for example, because many factories there use large quantities of steel and natural gas, materials that have seen dramatic increases in cost recently.

The employment report might come in below expectations, as well, Vitner suggested, largely because many companies are not hiring as many summer workers as usual. Productivity growth numbers suggest that companies want to increase their profit margins rather than hire workers, so there could be a large seasonally adjusted increase in unemployment. The result of such news would be a modest rise in the prices of Treasury bonds.

Corey B. Redfield, chief fixed income strategist with US Bancorp Piper Jaffray, concurred with Vitner. Friday's surprise in the Chicago PMI report could be a precursor to the ISM survey on Monday.

When the Chicago PMI surprised investors in February, the ISM number, released the following day, was above expectations.

Federal Reserve will watch employment figures carefully

If the Federal Reserve sees job growth, it will know that the unemployment rate is no longer rising. Joel L. Naroff, president and chief economist of Naroff Economic Advisors, said that the level of job growth will portend how soon unemployment will stabilize.

The bond market would react negatively only if the increase in non-farm payrolls exceeds 100,000. An increase of that magnitude could suggest that the Fed will tighten rates sooner than expected, Naroff explained. Any number below 100,000 will not generate a response from the fixed income market, he stressed.

Monday's ISM report should be confirmatory in light of the Chicago PMI report, he added. Markets probably will not respond unless the survey's results are well out of line with expectations of strength in industrial production.

Unemployment should remain at 6 percent, although the employment report may show a modest increase, hypothesized Kathleen Stephansen, director of global economics with Credit Suisse First Boston. Seasonal revisions could depress April's reported figure and raise that over number for March.

The fixed-income market will be range-bound. "Bonds are down, but holding up well" under the circumstances, she noted. Treasury bonds could be vulnerable to stronger data. If unemployment holds, the Federal Reserve will not tighten rates imminently, she added.

Likewise, John Puchalla, an economist at Moody's Investors Service, said there should not be a significant move in bond yields. A bigger increase in non-farm payrolls in May than in April could be negative for the Treasury market. Higher levels of employment will instill greater confidence in investors that the U.S. economy is emerging from recession. See economic forecast and calendar

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